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FEBRUARY/MARCH 2016 bankingexchange.com
Talent scouts Signature Bank’s Joe DePaolo and Scott Shay perfect “team liftouts,” to the chagrin of big banks
prepping for fasb reserve rules Core conversion in five months! 1
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/Contents February/March 2016
14 Talent Scouts It’s all about teams—97 of them. Read how Signature Bank has perfected team acquisition to the tune of 25 consecutive quarters of record earnings. By Bill Streeter, Editor & Publisher
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Up on payments Three banks’ strategies for retail payments innovation By Lisa Valentine, contributing editor
February/March 2016
BANKING EXCHANGE
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/ contents / 4 On the Web Return of deposit competition; Examiner from Hell is back; New mortgage rivals
February/March 2016 Vol. 2, No. 1
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6 Like it or Not Bill Gates may have been right (in part), but it’s still not all about digital
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8 Threads Speaking about digital... How about a chartered app? People, the credit wild card; Mix big data with video
Chairman & President Arthur J. McGinnis, Jr.
12 Seven Questions
Executive Editor & Digital Content Manager Steve Cocheo scocheo@sbpub.com
25 Risk Adjusted
Creative Director Wendy Williams
You may give thumbs down to FASB’s expected loss proposal, but you’d better prepare for it in case it sticks
Design Consultants Sarah Vogwill
The dreaded core conversion. Busey Bank takes the plunge, in record time
30 Idea Exchange Fast-growing thrift finds a birthday provides an unexpected funding gift
Editor & Publisher William Streeter bstreeter@sbpub.com
ABA’s new CEO, Rob Nichols on priorities, reg reform’s stall, millennials, and tech
28 Bank Tech
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32 Compliance Watch Reading the tea leaves on “fair banking,” increasingly on CFPB’s radar
36 Counterintuitive Eleven responses to “Who is a good customer?” Why that’s a problem
Designer Nicole Cassano Editorial & Sales Associate Andrea Rovira arovira@sbpub.com Contributing Editors Ashley Bray, John Byrne, Nancy Castiglione, Dan Fisher, Jeff Gerrish, John Ginovsky, Steve Greene, Lucy Griffin, Ed O’Leary, Dan Rothstein, Melanie Scarborough, Lisa Valentine Director, National Sales Robert Vitriol bvitriol@sbpub.com Production Director Mary Conyers mconyers@sbpub.com Circulation Director Maureen Cooney mcooney@sbpub.com Marketing Manager Erica Hayes ehayes@sbpub.com
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Editorial Advisory Board Jo Ann Barefoot, Jo Ann Barefoot Group, LLC Ken Burgess, FirstCapital Bank of Texas, N.A. Steve Ellis, Wells Fargo & Co Mark Erhardt, Fifth Third Bank Joshua Guttau, TS Bank Jane Haskin, First Bethany Bank Trey Maust, Lewis & Clark Bank Earl McVicker, Central Bank and Trust Co. Chris Nichols, CenterState Bank of Florida, N.A. Dan O’Malley, Eastern Bank Dan Soto, Ally Bank McCall Wilson, Bank of Fayette County
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/ ON THE WEB / Popular Stories on
bankingexchange.com
Ready for return of deposit competition?
Even going on a branch diet’s going to cost you
The examiner from Hell, revisited
Been a while since your bank exercised its deposit-gathering muscles? Neil Stanley diagnoses the cause of “deposit atrophy” and suggests some cures to what is going to be ailing you. Read more at http://tinyurl.com/depositatrophy
“Paper transactions and foot traffic in bank locations is of the last decade,” says KBW’s Collyn Gilbert. “It’s not the way the operating environment is going to be.” But disposing of branches can cost plenty. Read more at http://tinyurl.com/branchsale
During the financial crisis Jeff Gerrish blogged about “the examiner from Hell,” who made banks miserable. Examiner relations have improved, but Gerrish says the examiner from Hell has been spotted again. Read more here http://tinyurl.com/ExaminerHell
Biggest mortgage rivals may not even be local Keep your binoculars on the bank across the street and you may miss the mortgage competitor that is only a few clicks away. CCG Catalyst’s Paul Schaus says the home loan business isn’t what it used to be—and hasn’t been for some time now. Hey, even grandma has an iPad now! Read more at http://tinyurl.com/ mortgagerivals
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/ like it or not /
It’s not all about “digital”
W
ell before “fintech” became the word of the moment, technolog y leaders were taking pot shots at banks. The practice dates at least to Bill Gates in 1994 saying, “Banks are dinosaurs, they can be bypassed,” and has continued to today’s change agents—among them Brett King, host of the “Breaking Banks” web radio program, who says banks must radically transform to survive. Was Gates wrong, or just ahead of the curve? Will banks look back on “Breaking Banks” as just a passing phase? Or has the game changed radically? Shock talk has value, even understanding that the motives behind it are not always self less. It gets attention, and it gets people feeling uncomfortable, which, as we’ve noted before, is good. Now we have the new head of the American Bankers Association weighing in on tech-related change. In “Seven Questions” (p. 12), Rob Nichols says many young people believe they don’t need a bank. If true, that’s more than an image problem. And he rightfully f lags it as a serious concern. Yet here’s an interesting thing. We’ve recently highlighted two very successful banks (measured by both growth and profits). One, SBA-specialist Seacoast Commerce Bank, in the previous issue, and the other, Signature Bank, a $33 billion New York City institution that has just posted its 25th consecutive record quarterly earnings. (See story on p. 14.) Neither of these institutions are tech leaders. They are niche leaders and profit leaders, however, and are active watchers of trends—tech and otherwise. So how do you rationalize a Signature Bank, which doesn’t have traditional branches, yet emphasizes high-level personal service, often provided via telephone or in person, with calls for banks to digitally transform themselves? Part of the answer is that Signature does not cater to retail customers. It leaves that to the big banks. The bank’s target—urban, mid-size, private businesses—still value personal ser v ice, delivered mainly in person. But for how
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long? Won’t these businesses also want the kind of simplicity and access that mobile solutions provide? Signature is not a tech throwback by any means. They invest in technology, but generally pursue a follow-not-lead strategy. It’s common in certain circles to say that such an approach is outdated. That’s nonsense. Even the tech giants let small, promising innovators pioneer new applications, then acquire them. Technology in some ways has degraded service, because it dangles the false god of cost savings, leading to cutbacks in trained staff in areas where humans are needed. A point that gets lost in all the focus on technology, generational change, etc., is that you have to please the customer if you hope to succeed in business. Please them with product, service, price, ease of access (“reduced friction”), and more. Even the tech-savviest consumer on Earth isn’t really consuming technology. When they choose a streaming media service, it’s because it offers an easier or better or cheaper means to get something. And when there is a question or a problem, consumers want it solved as quickly and as easily as possible, by whatever means they prefer—text, e-mail, phone call, in person, or social media. The main thing is: Do they get what they need promptly? Signature Bank’s mid-size business clients so far haven’t expected the latest mobile technology from the bank (although many require state-of-the-art cash management). What they do expect and value is a close relationship and service. The bank will add whatever technology is necessary to meet that need. For banks with a more typical commercial/retail business mix, the dynamic is not really different. It’s just that retail customers’ attitudes and preferences often change more rapidly. Gates was partly right. Banking with a bank is not a given. Meeting peoples’ needs is. A lot of that involves technology, but the challenge is to know what to change and when, without taking your eye off the fundamentals.
BILL STREETER, Editor & Publisher bstreeter@sbpub.com
A point that gets lost in all the focus on technology, generational change, etc., is that you have to please the customer if you hope to succeed in business
Competitive intelligence for bankers
March 2015 bankingexchange.com
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The key to dealing with disruption, says TS Bank’s Josh Guttau: Do some disrupting yourself
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/ THREADS U.K.’S CHEEKY CHARTERED APP
Is the mobile-only bank a harbinger for U.S. endeavors? By John Ginovsky, contributing editor
A
new bank in England seeks to reinvent banking—owning its own charter while operating in the United Kingdom only through a mobile app, initially. Its model could resonate elsewhere, doing to U.S. banking what the Beatles did to Pat Boone—blowing him off the pop charts. Atom Bank presents itself as a new option. It brashly proclaims its ubiquity, simplicity, and accessibility. For now, it will be available on Android or iOS apps. “Everything we do is different,” it says on its web page (www.atombank.co.uk). “We’ll offer an app-based experience like no other, using leading technology. The digital world is constantly changing, and Atom will be changing banking, too. Oh, and we don’t have branches.” The bank’s communications are a bit cheeky, intentionally. For example, one FAQ asks: “Why should I change banks?” Answer: “We’ll be bringing banking to you, and we’ll be looking out for your best interests. Sound unfamiliar?”
Cheekiness aside, what makes Atom Bank different from other mobile-only banks is that it directly obtained a banking license from the United Kingdom’s Prudential Regulation Authority and is regulated by the Financial Conduct Authority. In the United States, mobile banks, such as Moven and Simple, function through the licensing and regulatory scrutiny of associated traditional banks. “Having a banking license means that we can design the entire end-to-end model of our bank,” Mark Mullen, CEO, tells Banking Exchange. “By controlling every aspect of our bank, we believe we’ll be able to deliver a low-cost, but exceptional banking experience.” Atom Bank got off the ground last year after an unspecified number of investors raised £25 million ($36 million), followed by an additional £45 million ($65 million) investment by BBVA. As of January, Atom Bank was running in closed beta and planned to launch “towards the end of the first quarter of this year.”
It’s not only banks Banks are the fifth most regulated industry, according to the latest Industry Regulation Index. (Ahead of banks are energy companies, electric utilities, auto manufacturers, and nonbank lenders.) The 16,033 restrictions bankers face compares to 1,130 for the median industry. Source: George Mason’s Mercatus Center RegData.org
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cfr* paper trail The 174,545 pages end to end would stretch nearly 25 miles
*Code of Federal Regulations (all federal government rules)
Once open, anyone living anywhere in the United Kingdom will be able to open an account on a mobile phone, using a passport or driver’s license. Atom promises to offer all types of banking services and products, including payments, savings, mortgages, and loans for both business and retail customers. Of the concept, Mullen says: “We believe in using technology to provide a personalized and unique experience, bringing customers closer to their money, keeping them informed and in control. We’ll keep things simple and allow customers to do things themselves, keeping our costs low, meaning better value for [the] money.” One differentiator is its pioneering (in the United Kingdom) use of face and voice biometric log-in capability. “Present your face to view your balance. Or say a few words to transfer some money. Atom wants to ensure the registration and login process of banking is as simple, and most importantly, safe as possible,” says Max Cooper, marketing analyst at Atom. The bank will use Daon’s mobile biometric authentication platform IdentityX, which USAA has used for years. Cooper says that Atom will use a tiered approach to security: Once a customer’s credentials are registered in face, voice, and passcode modes, she may choose how to log into the app. For unusual or highvalue transactions, the bank will ask for additional security checks.
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60
Shakespeare’s works
Harry Potter series
wide reach, and complete dependence on mobile channel delivery. Could that model work here? Mullen believes it’s transferable to other markets. “Digital adoption trends and audience behaviors are similar between the United States and the United Kingdom, with the U.S. leading the way in many aspects.” His only caveat is that “the model would need to be adapted to ensure it was fully compliant” with the U.S. regulatory system.
Nearly 3 years
(reading time in hours)
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Atom tells prospects: “We’ll bring banking to you, and we’ll be looking out for your best interests. Sound unfamiliar?”
cfr read time
cfr vs. literature
The Bible
Cooper says facial recognition is robust. “There’s no need to be worried about appearance changes. Whether you’ve spent two days in the sun and have a killer tan, just got a trim at your local barber shop, or grown a lumberjack-like beard, none of this will matter.” It’s clear, though, that the biometrics aspect of Atom Bank only complements the new model it hopes will catch on. That is: a relatively small capital investment, initial government licensing, country-
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Game of Thrones series (1-5)
5,727 CFR
February/March 2016
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/ THREADS / People, the wild card in credit
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f you hear of a system that can insulate a bank from credit risk, be skeptical and remember that most business lending still entails the “human element.” At a Florida regional where I was a loan officer, I declined a request for a performance letter of credit based on a provision in the bank’s loan policy. When one of my bosses heard, he said with a faint smile: “I’d have found a way to do that. . . .” Well, there was a way that I could have evaded the internal controls, but I chose not to. I never forgot the tone this man set with me and, perhaps, others—the implication that rules were made to be bent. Most internal controls are verif i a b l e a s to t h e i r co m p l i a n ce. Incomplete documentation gives rise to exceptions that are generated, tracked, and cleared by persons independent of the lending of f icer. But do the controls operate as intended? Banking is a service business, and good service means meeting customer needs on a timely basis. Sometimes, circumstances stand in the way, and the human tendency is to compromise the control. Ultimately, do lenders have what it takes to stand by their training, policies, and experience? We must understand our limitations. Our risk abatement efforts must be habitual, systemic, and continuous. Remember: We are relying on fellow human beings whose actions defy precise modeling. – Ed O’Leary, contributing editor Read the full blog at http:// tinyurl.com/people-risk
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TELL ME IN VIDEO
Big data gives video messages new impact By Ashley Bray, contributing editor
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ouTube videos are great, but static. They’re the same for every viewer. What if you could use data you have about your customers to tailor video messages to their needs and interests, and allow them to interact with the video? Dave Schwa r tz , v ice -president of Digital Commerce Solutions for Pitney Bowes, thinks financial institutions are primed for such a tool as they strive to find better ways to connect with customers. Most f inancial institutions, he observes, have an average of seven channels of communication with customers—website, por tal, app, direct mail, email, SMS, and social—and the majority of those happen digitally. Pitney Bowes recently launched a new ser vice, called EngageOne, that delivers individualized video communication to consumers through any device they choose. One use is for customer onboarding, especially getting customers to reg ist er t o t he ba n k ’s por t a l. That early digital engagement is critical to
future interaction with the client, says Schwartz, because as they age and their financial lives change, a bank has the opportunity to capitalize on their needs. Video personalizes digital onboarding and incorporates data fields and other choices that both engage the customer and capture data. Later comes the need for increased education, and video allows customers to learn at their own pace. According to Schwartz, personalized videos can make a dry subject, such as insurance policies, more interesting. “It’s really the visual reinforcement of the words being spoken,” says Schwartz. “It’s just a lot easier to absorb content.” Schwartz says the running time for videos that explain billing and other statements is usually under three minutes. For customer acquisitions, videos can go as long as 30 minutes. “But across the board, if we looked at all of our service offerings, the average viewing length is right around six minutes,” he says. To view a Pitney Bowes demo, visit http://mypbvideo.com/bnkexchmag
Reg haze slows home LENDERS
Washington’s reform fumble confuses lenders, impairs mortgage flow By Melanie Scarborough, contributing editor
T
he Portfolio Lending and Mortgage Access Act, introduced in the House last year, would have allowed any mortgage held in a bank’s portfolio to be considered a Qualified Mortgage—precisely the sort of risk retention Dodd-Frank aimed to ensure. Yet after the House passed the bill, the White House said the Senate need not consider it because the President would veto it. What does this mean for the mortgage market? “There’s a general back-off and slowdown in the marketplace,” says J. David Motley, president of Colonial Savings, a $1.1 billion-a ssets institution based in Fort Worth, Tex. “Lenders have shied away from the edges of the credit box, because they don’t want to be found guilty of breaking a compliance rule.”
Hitting “redo” 4x per loan Given the inscrutability of many new regulations—and the unknowns of what would warrant penalties—mor tgage lenders must take measures to be sure they don’t run afoul. For instance, Colonial Savings recently discovered that its programmer left off a minus sign on the new TRID form next to the line indicating credit to the borrower.
guidance issued on that.” The Consumer Financial Protection Bureau’s “strategy was to make the rules a little nebulous so lawyers could file suit and lenders would be cautious,” Motley speculates.
Dissatisfied consumers
Lenders shy away from the edges of the credit box to avoid breaking rules “They programmed the amount correctly, but no minus sign was there,” says Motley. “Our auditors said that’s an error.” “We find ourselves redoing a disclosure about four times for every loan we close,” Motley explains. “If there’s the slightest error, like a borrower being referred to as ‘Richard Smith’ in one document and ‘Richard E. Smith’ in another, we’re going to reissue the closing disclosure, because we don’t know if that error is punishable in some way. There’s been no
If that truly was the regulatory strategy, lenders aren’t so sure that CFPB accomplished its ostensible purpose of protecting and better serving mortgage consumers. “What happens when the borrower says, ‘I don’t have $2,500 for closing; increase my loan’?” wonders Cynthia L ow man, president of United Bank Mortgage Corp., Grand Rapids, Mich. “We cannot, and there’s no answer for how we can accommodate the customer.” Don Calcaterra, Jr., president of Towne Mortgage Company, a non-bank lender in Troy, Mich., says, “We’re being more conservative and taking longer to do loans, but that creates problems for consumers.” Calcaterra suspects that while the new rules drove out some bad actors, others simply moved underground. “A lot of people making predatory loans are not in the oversight of the regulatory agencies.” Read the full article at http://tinyurl. com/reg-haze
Beyond simple disruption
To succeed: Start evolving now Book review by Jane Haskin, First Bethany Bank
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et the hang of evolution or prepare to face your institution’s end. Chris Skinner issues this warning in his new book ValueWeb, which looks at the value added by new technology and the way it changes how we value things in finance and life. Skinner defines the ValueWeb as the alternative banking system that fintech is building. He believes that banks have about ten years to retool and become digital, too, putting the customer needs at the center. How can banks do this?
• Weigh the branch. Even digital banks open branches to gain trust. • Improve service. Stored customer information is valuable. Use it. • Give up “generalism.” Capitalize on what you do best. • Reinvent yourself. Future transactions will be free. Add value with products that customers will pay for. • Rethink your “insides.” Don’t rework your legacy core processing. Get a new digital core. Read the full book review at http:// tinyurl.com/ValuewebReview February/March 2016
BANKING EXCHANGE
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/ Seven Questions /
ABA’s new man at the top
Rob Nichols calls on the industry to reassess its advocacy, but also to focus on non-governmental threats By Bill Streeter, editor & publisher
I
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don’t want to just represent the banking of today,” says Rob Nichols. “I want to be mindful of what the banking sector will look like five, ten, 20 years from now.” That’s an indication that the new chief of the American Bankers Association is not solely focused on near-term lobbying goals. Having spent four and a half months as “incoming CEO,” Nichols on Jan. 1 dropped “incoming” from his title and became president and CEO of ABA, succeeding Frank Keating, who retired. Nichols, 46, was raised in Seattle and is a graduate of George Washington University. He worked on Capitol Hill for two Washington State elected officials, the late Rep. Jennifer Dunn and Sen. Slade Gorton, both Republicans, and as an aide in the office of the Chief of Staff for George H. W. Bush. Later, he spent four and a half years at the Treasury Department, where he was assistant secretary for public affairs. Following his Treasury stint, Nichols joined the Financial Services Forum as president and CEO in 2005, where he remained until last July. The Forum comprises the CEOs of 18 of the largest financial institutions with operations in the United States. The current chairman is Brian Moynihan, CEO of Bank of America. In addition to a focus on advocacy, Nichols, a regular Twitter user, will position ABA to help prepare members for the convergence of banking and technology. The following dialog has been edited for length and clarity. Q1. You had a long transition period. How did you make use of that time? It afforded me an opportunity to reach out to key stakeholders, one being state association executives. I invested much of that four and a half months in getting to know that group. Number two: I assessed the staff. I went to a lot of the divisional staff meetings, walked the halls, and got to know the team. And three: I did outreach to member CEOs, starting with the board, of
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course, but then moving past that to CEOs of community banks, regional banks, midsize banks, and some of the larger banks. The reg ulator y and leg islative stakeholders, and people in the administration, I’ve known from the other positions I’ve had in Washington. Q2. Now that you’re past the transition, what policy or organizational areas will you be focusing on? Four areas are important from a strategic standpoint. Regulatory relief will remain hugely important, particularly given that we achieved little in the way of relief in the last session of Congress. Focusing on the supervisory framework—which is ill-suited and wrongly tailored, in my opinion, particularly for smaller banks— will remain a key area of focus in 2016 and, certainly, 2017. Number two is bank unity. Ending “bank-on-bank violence” is extremely important, particularly as it pertains to advocacy. There’s been a Balkanization of the banking sector over the last several years, much of which has been caused by the artif icial thresholds of Dodd-Frank—$1 billion, $10 billion, $50 billion. We have more influence and more
clout by working together than apart. Also, our existential threats are not banks of varying sizes, but non-bank lenders, credit unions, changing demographics, and technology. Three: Millennials are now the largest chunk of our nation’s demography at 84 million. Research suggests millennials would rather go to the dentist than hear from their bank. There’s an alarming number of them who don’t think they’ll ever need a bank—who don’t see the utility of our services. We need to think about how do we speak to them, how do we market to them. Last is the rapid convergence of banking and technology. In 2014, about $12 billion went into fintech. I suspect when they calculate 2015, it will probably be $20 billion to $40 billion. To the extent we can, we should try to partner with these companies. But, at the very least, we need to be mindful that we don’t create another unlevel playing field. We already have that with Farm Credit and credit unions. The last thing we need is a new group of market entrants offering products and services close to identical to what a bank offers, where we are highly regulated and they are not.
Q3. Every time the industry’s image seems to improve, a fresh reminder of 2008 comes out in the form of a settlement, a movie, or what have you. Do you think anything can be done to overcome that? As an industry, we’ve had signif icant reputational headw inds that impact the conversation with the administration, legislators, and regulators. The one thing that we have to our advantage is that there is no other industry that can do what we do in the form of economic growth and job creation. When you talk to millennials, so many of them want to be involved in making their community better. I think we can say to them: “You want to make an impact in your local community? Go work at a community bank, and you w ill quick ly discern how bank s can make an impact.” Q4. ABA represents the entire industry. How do you keep all the players working together, given that all the various segments do not always like each other or agree on the issues? Part of what was so appealing about the ABA is that it represents all banks. It is the one group that can be the leader on this issue of bank unity. I’ve talked about this to several bank CEOs—at banks of all sizes—and they agree that a unif ied sector will have more influence and clout. When I served on Capitol Hill, I worked in a tech-centric congressional delegation. When different [tech industry] groups would present different priorities, the takeaway for the elected officials was: “This industry is all over the place; they don’t seem to have any common vision or message. I’m not going expend any capital to help them.” I also would note that bad policy proposals trickle downhill. If you look at Dodd-Frank, you see a lot of negative consequences that have been thrust upon smaller banks. I’ll say this, too: Our financial ecosystem is interdependent.
Q5. You speak of the importance of unity, but in reality, ABA and Independent Community Bankers of America compete for membership and on other levels. Do you see that changing? I’ve been involved in advocacy for the financial sector for a very long time, so I have pretty sharp views on this. On any big advocacy campaign, we are stronger together as a community. I’ve spent a lot of time with the other financial trade groups. They are stakeholders as well. So when a strategic course of direction on any kind of legislative issue is set, my immediate goal is to call the heads of all the other financial trades and say, “I think this particular strategic direction make sense; let’s work on this together.” I’ve seen advocacy up close and personal both in and out of government, and when the business community is united, they are just simply more effective than when they’re not. I realize there are members that overlap among the various groups. I get that. But from an advocacy standpoint, we are simply stronger when we work together. When you look at the last five years, much of how we’ve been measuring success has been stopping additional bad things from happening. And that’s not an encouraging way to measure success. Because of that, the idea of working together resonates. Q6. Regarding the failure of major regulatory reform legislation to move in 2015, how do you look at what happened, and what are the prospects for 2016? It was extremely disappointing that the omnibus spending bill did not contain some measures of regulatory relief, particularly for our smaller banks. I think there was a huge lost opportunity to help improve the economy. Obviously, trying to pass regulatory relief on a spending bill is not ideal, but there just were not other opportunities to move that legislation. The general discord and dysfunction in Washington is creating huge headwinds, and the fact that there’s very little standalone legislation is troubling. On top of that, having
all banks over $10 billion pay for a significant portion of the highway bill was highly offensive, in my view. This yea r, obv iously, w ill be ver y challeng ing to do leg islation in any a r e a . W hen you lo ok at 20 08 a nd 2000—the eighth year of a presidency coinciding with a presidential election— typically very little significant legislating gets done. That said, we will keep pushing. We have folks in the House who are interested in trying to help, and Sen. Shelby (R-Ala.), as well as a number of Democrats [in the Senate], made it clear that they want to try to move regulatory relief. Last year served as a wake-up call for the entire industry for how poorly many in Congress view banking. As a sector of the economy and as a group, we need to
Our existential threats are nonbank lenders, credit unions, changing demographics, and technology be very deliberative and rethink about how we engage with Washington. Q7. What things need to change? I think we should take a step back and look at every way that our sector interacts with the public policy community. The entire architecture of our political engagement and how it’s viewed should be assessed. I believe we should be more politically muscular. We’ll determine, over the weeks and months ahead, precisely what form that should take. We’re going to have a new president and we’ll have a new Congress in 2017. That’s an opportunity to hit the reset button with Washington. So 2016 will be a year of organization, a year of assessment, a year of ref lection, and a year of planning to get ready for 2017, when we’ll again have a whole new group of players in Washington. February/March 2016
BANKING EXCHANGE
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e’re different. Our W name on a building is not as important as the name of the banker meeting with prospects” – Joe DePaolo, CEO
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they bring their “a” game every day Signature Bank’s model has held up remarkably well over a 15-year run-up to $33 billion. How far can it go? By Bill Streeter, editor & publisher
Bill Alatriste
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or big-bank CEOs reading this stor y, here are two takeaways up front: 1. If you shoot hoops with Joe DePaolo, and play his game, you’ll lose. 2. If you compete with DePaolo’s bank at its game—relationship banking for private, urban middle-market companies—you’ll lose. Interested in knowing why? You’ ll notice something about Joe DePaolo’s office at Signature Bank—after you take in the view of the Empire State Building looking down Fifth Avenue. The walls are bare. The president and CEO keeps photos of his family on a bookshelf and behind his desk. But no artwork, testimonial plaques, degrees, etc., are hanging on the walls. “I keep my walls bare to remind me I’m a visitor here,” says DePaolo. “I don’t want to get too comfortable.” Spoken like a coach of a sports team whose success can be fleeting. For a time, DePaolo, one of the founders of the bank, considered high school coaching as a career choice. He was a point guard on his high school basketball team. In college, he chose accounting over coaching, which led to a banking job at New York’s Republic Bank (since acquired by HSBC Bank) and then Signature Bank. Despite that sw itch, DePaolo, who grew up in the New York City borough of the Bronx, has always kept his love of basketball. For his 50th birthday, his wife arranged to have him meet and play ball with New York Knicks legend and Hall of Famer Walt “Clyde” Frazier. The two men hit it off. When it came time to play, DePaolo knew he couldn’t beat Frazier playing one-on-one, so he suggested they play “HORSE.” In this game, each player calls
the shot he will make—often a trick shot. If he makes it, the other player has to match it or he “earns” the letter “H,” etc. Frazier agreed. What he didn’t know was that DePaolo can shoot “lights out.” The banker took two out of three from the seven-time All-Star, who, although 70, remains in good shape. “Frazier has told people about it,” DePaolo says with a grin, adding that the two of them have stayed in touch. The story is an apt analogy for what Signature Bank has done over the last 15 years. It has played on the courts of the big New York City banks, played its game, and won hands down.
Bank of teams In post-game interviews with star athletes, they always say that winning is a “team effort.” It’s very much the same at Signature Bank, where in interviews and annual reports, management talks about the team. Except that in this case, it’s not the team, but the teams—all 97 of them, as well as the folks who support them. These “Private Client Banking Teams” are, in fact, the keystone to the bank’s incredible success, growing from startup in 2000 to $33 billion in assets, and currently on a run of 25 consecutive quarters of record earnings. The bank was profitable within 21 months, went public in 24, and repaid its initial $42.5 million capital infusion from Bank Hapoalim in just four years. From that point, Signature Bank has never looked back, including during the financial crisis when it never even had a down year. The bank’s modus operandi—acquiring teams of bankers from much larger b a n k s —i s n o l o ng e r n o v e l . (S o m e
investment bankers refer to such a “team liftout” now as the “Signature model.”) And while Signature Bank’s three founders likely were not the first to apply this practice, they have certainly perfected it. Each team operates as a quasi-independent , single point of contact for Signature Bank’s middle-market clients.
Signature highlights
Full-year 2015 over 2014
total assets $33.45 billion up 22%
deposits
$26.77 billion up 18.4%
net income $373.1 million up 26%
loans
$23.79 billion up 33.2%
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/ SIGNATURE /
n investment banker once A said to me, ‘You are the only bank that doesn’t do such and such.’ That’s exactly the reason I don’t want to do it” – Joe DePaolo, CEO
One of severa l remarkable things about the bank is that in its run-up from a niche de novo to a $33 billion-assets institution, it has not changed the fundamentals of how it operates. Hiring people from big banks is a longstanding tradition at small and midsize banks. What makes it work so well at Signature Bank is that the practice is combined with a singular focus on client relationships; a balanced, simple incentive compensation plan; disciplined underwriting; and a minimum of middle management. The result is highly appealing and very sticky to both employees and clients. (See “Inside Signature Bank’s playbook,” opposite, for more details.) Now, as it prepares to operate in the world of systemically important financial institutions, the question is: How long can this bank’s remarkable run continue?
First, get their money Signature has, from the get-go, been a bank that puts its depositors f irst. Though management doesn’t explain it this way, the bank operates as if there 16
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were not deposit insurance. “We don’t worr y about making ten ex tra basis points on yield or on loans,” says Chairman Scott Shay. The bank has always been, as he says, a “sleep-at-night” bank. The bank is highly capitalized, and delinquent loans are few (see accompanying highlights chart, p. 18). I n a 2 0 0 8 i n t e r v i e w, D e P a o l o explained, “Everyone thinks of banking as lending. I think of banking as bringing in deposits. If I have to give you money, it’s easy to bring you in as a client. If I have to get your money, it’s harder. Fundamentally, our belief is you build the bank for the deposits.” This view has not changed. The bank’s incentive compensation plan actually gives more credit for deposits than for loans. What has changed is the amount of lending the bank does. As Shay explains, the last thing they wanted to be as a startup was the “lender of last resort”— booking credits no one else wanted. So they were deliberate in lending, investing excess deposits in conservative investments. Signature lost quite a bit of money
at first, but not from bad credits. Once management embraced commercial real estate lending in 2007, the loan portfolio grew quickly: from 17% of total assets in the early years to about 40% in 2008, and to 71% now. According to DePaolo, they made the decision to get into commercial real estate lending (but not construction lending) because the banking teams were saying they had clients with real estate needs that the bank couldn’t meet. The bank took the plunge using what has become its “signature” method—lifting a veteran team from a much larger bank. In this case, it was North Fork Bank, which had been acquired by Capital One the year before. Since then, CRE lending has become the biggest component of Signature’s loan portfolio at about 78%, with 48.9% multifamily and 28.9% other CRE. Shay says that, in general, Signature’s most typical CRE customers are multitenant properties. “We do nothing that’s not cash flowing,” he points out, “and our real sweet spot is multifamily apartment
complexes in the boroughs [the five counties that comprise New York City].” The bank’s average loan size, including CRE, is $4.5 million. “We’re not trying to finance the World Trade Center or the General Motors building,” says Shay. “We’re generally financing buildings that people live in, that have lots of tenants and cash f low, and don’t have any singular risk.” By contrast, he explains, the bank hasn’t done construction loans in a long time because they’re not cash flowing. “We don’t feel like we’re getting a return that’s appropriate for the risk depositors are taking.” Shay points out that one of his favorite sayings—one that helps him sleep—is that loan-to-value ratios don’t pay back loans. Cash f low does. You begin to see the drift here. “You can almost close your eyes to the interim values” on a loan to an apartment building with 150 units, says Shay. “It’s going to pay you back.”
Limitations and line extensions
Even though Signature’s core strategy has carried it over the threshold of the top 50 U.S. banks, some analysts wonder if the strategy has an upside limit. Responds DePaolo: “I think there are limitations if you go beyond the concentric circles that we build,” referring to the gradual expansion outward from the New York City boroughs into the adjacent counties and states. “If we jumped to Chicago or Dallas, it would be hard to do business where the team reports to me or my senior management group in New York.” DePaolo says that the bank would likely have to set up a similar structure in those cities. But the numbers alone—asset size or number of teams—won’t limit them, DePaolo maintains. He points out that while the strategy hasn’t changed, how they implement it has. “When we first started out, I had all 12 teams doing just about everything through me. As time went on, I became a log jam. So then we said if you have an operational issue, go to the chief operating officer, not me. For credit, they would go directly to the chief credit officer; for interest rate questions, to the treasurer.” Technically, 141 group directors are direct repor ts to DePaolo (there are 97 teams, but several have multiple
directors), but he has Vice-Chairman John Tamberlane, the third of the bank’s founders, and Executive Vice-President Eric Howell supporting him. And he brings in the human resources director and others as needed. “It’s not as onerous as you think,” he says. The reason for that is because the group directors are all experienced bankers, not trainees or newly minted MBAs. They have decades of experience and don’t need hand-holding. “How am I supposed to tell someone, who’s been developing business for 35 years and has a book of business the size of many banks around the country, how to grow his business?” DePaolo asks. “I’m there to remove obstacles.” Signature’s CEO didn’t tip his hand as to whether he has any plans to establish the model elsewhere. Although he did say that it could work in Dallas, Los Angeles, Philadelphia, Boston, Chicago, or any large city where big banks operate. But DePaolo may not need to take the show on the road. First, there is plenty of business to tap in the New York metro area. Second, Signature has entered several niche banking markets over the past several years. These include equipment leasing and finance, asset-based lending, and municipal f inance. These businesses operate nationally, and yet, in many ways, follow the same pattern as the rest of the bank—setting up shop and growing by acquiring teams. Signature Financial was formed in 2012 initially to engage in equipment finance and leasing. Team leaders had been telling management they were losing out on opportunities to do additional business with clients. For example, the bank handled the operating accounts of an ambulance company, but wasn’t financing the ambulances. As management studied the business over several years, they realized that to get the kind of returns they wanted, the operation needed nationwide scale. Eventually, they found a large team (55 people) that had been together for a long time and was willing to move en masse to Signature Bank. In 2014, Signature Financial expanded into commercial marine lending and franchise finance, again w ith veteran bankers brought aboard. The subsidiary then accounted for 12.7% of the Signature’s loan portfolio in 2015.
Inside Signature Bank’s playbook
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ine points sum up Signature Bank’s winning model: 1. Target privately owned, mid size bu sines ses (gener all y revenues of $5 million, or large deposits) for which a relationship with a bank is highly valued. 2. Provide a single point of contact for each private client business. 3. Acquire teams—called Private Client Teams—from larger institutions. (Typically, teams include an experienced business develop ment of ficer and suppor t staf f.) The team brings clients with it, and “owns” them. 4 . Te a m s d o n o t u n d e r w r i te loans. That’s done by senior lenders reporting to the chief credit officer. 5 . Ea c h of t h e te a m l e a d e r s reports to the bank’s CEO. There is no middle-management layer overseeing the teams. 6. Middle-management expertise, however, supports the teams in compliance, underwriting, cash management, technology, etc. 7. Incentive compensation for team members is based on the business their team develops (minus any that leaves). Each team has its own bonus pool, with no cap. 8. Support staff (tech, credit officers) receive subjective incentive compensation, based on an assessment of their performance. 9. Teams do not have assigned territories. They arrive with a book of business, typically based in a particular area. CEO Joe DePaolo says instances of team conflict over new business are rare.
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/ SIGNATURE / “ Raiders of the big banks”
More Signature numbers
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he co n so lid a t io n am o n g New York City’s large and midsize banks over 20 years has created a vast talent pool for Signature Bank. In these mergers, t ypically the big banks homog enized commercial private clients, rolling them into retail. Team leads come from various sources. One is when the accountants and lawyers the bank works with say, “I know Bill and Joe are unhappy at X YZ Bank. You may want to give them a call.” Sometimes, Signature’s existing bankers know of former colleagues who weren’t ready to make the move initially, but are now. Clients are another source. In 2015, Signature brought five teams on board for a total of 97. E xe c u t i ve V i ce - P re s i d e n t E r i c Howell and Vice-Chairman John Tamberlane meet with prospects f i r s t . N ex t s te p i s to h ave t h e potential team leader meet with Signature’s credit and cash management people. They have to feel comfortable that a much smaller bank can provide clients with the kind of services they need. If all that works, DePaolo meets them. T h e w o r d “ a c q u i r e d ,” u s e d above, is apt. DePaolo and Tamberlane were involved in bank acquisitions at Republic Bank, but now avoid them. “We’re bringing over businesses without buying the business,” says DePaolo. Has the bank ever had one of its teams lif ted? “Only t wice, and neither book of business left the bank.”
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Year-end 2015
Year-end 2014
Nonaccrual loans to total loans
0.30%
0.12%
Allowance for loan and lease losses to total loans
0.82%
0.92%
Net interest margin
3.26%
3.29%
ROAA
1.23%
1.20%
ROAE
13.85%
13.81%
Efficiency ratio
33.64%
35.07%
Tangible common equity
8.65%
9.14%
Tier 1 risk-based
11.33%
13.49%
Capital Ratios:
The bank added asset-based lending in 2013 with the addition of another team, and municipal finance and commercial vehicle finance in 2015. Just so you don’t think that everything it touches turns to golden earnings, Signature was one of several banks hurt by Uber’s impact on the ta xi medallion loan market. (Medallions, issued by municipalities, trade on an unofficial market. Pre-Uber, they could be valued in excess of $1 million in New York City; less elsewhere. Now, they have plummeted in value with few transactions.) Through the fourth quarter, the bank’s chargeoffs have been small, though the troubled niche portfolio has pushed up its nonaccruals. It was an unforeseen situation, DePaolo obser ves. No other medallion lender exited the business prior to the “Uber effect,” he adds. “Something is always out there” that you can’t anticipate.
invisible bank A couple months ago, DePaolo relates, “an investment banker said to me in a meeting, ‘You know, you are the only bank that doesn’t do such and such.’ Everybody in the room that worked with me went, ‘Oh no!’ They knew that was the worst thing to say to me, because that’s exactly the reason I don’t want to do it.” Given that insight, it shouldn’t be quite so hard to imagine a $33 billion-assets bank that has no social media presence. Granted, Signature is not a retail bank, but even many business-oriented banks can be found on Facebook or Twitter. Signature is almost invisible to the
public at large. Of its 29 offices, only a couple are at street level. The rest are on upper floors of buildings. The bank does no advertising, except in support of a client, according to DePaolo. Signature’s name on a stadium or a building? “Waste of money.” Radio ads? “They all sound the same.” “We do things differently from others,” says DePaolo. “That name on a building is not as important as the name of the banker that is actually meeting with prospects, so we have no line on our books for advertising.” Signature does have a web page, but not social media. “ W it h t he client s we t a rget [pr ivate middle-market companies], and their families—even the younger members—it’s meeting face-to-face” that’s important. “It’s letting them worry about their business and letting us take care of the banking and financial side of it.” DePaolo has not closed his mind to social media, however. “I don’t want to have blinders on,” he says. The bank will adjust, if necessary, he adds, as it has in other areas. DePaolo has a healthy paranoia about cyber fraud, and believes that social media would only expose the bank more than it already is. As he says, “There are thousands of 15-year-olds in their basements saying, ‘Okay, let’s attack this place.’” DePaolo doesn’t want to give them any more reason to do it than they already have. When it comes to Kabbage, Lending Club, and other non-bank marketplace lenders, some of whom are active in
business lending, DePaolo is up to speed on what it is that they do. But given his client base, he doesn’t see it as a threat at this point. “I’m not trying to stick my head in the sand, but I know our clients,” maintains DePaolo. “They’re a little bit larger than small business, and they want to be able to touch and know that there’s a human involved, even the next generation. So we’re watching the landscape rather than leading the landscape. Where we do lead the landscape is in service and in growing, but I don’t think we’re going to lead in technology.”
biggest challenge Given his concerns about cyberfraud, you may think that issue is DePaolo’s top concern in 2016. It’s not. The big gest cha llenge “ w it hout a doubt,” he says, is compliance as the bank has grown. The bank has been preparing for the $50 billion Dodd-Frank threshold for some time. “We don’t want an expense in any
particular quarter or year that’s so out of range, so we’ve started building now,” DePaolo says. The bank brought in a consulting firm to help it get ready for DFAST (DoddFrank Act Stress Test). It also had the consultants look at the organization from a risk perspective in terms of getting ready for CCAR (Comprehensive Capital Analysis and Review) requirements that kick in at $50 billion. Of this preparation, DePaolo says: “It’s costing us millions.”
no potted plants Signature does keep a low prof ile in many ways, including lobbying. Chairman Shay takes the lead here, and his ef for ts mirror the bank’s core operating pr inciple—relationships. O ver Shay’s career, which included working in private equity with Lew Ranieri, he has met many government officials. In fact, he first met Barney Frank in 1990 and was very impressed with the former congressman’s intellect. Fast forward to 2015, when Signature
announced the appointment of Frank— cocreator of the Dodd-Frank Act—to its board. “There was about 15 minutes of people thinking we were crazy,” DePaolo admits. Since then, he says, many people have called to say what a “brilliant move” it was. Their thinking, he says, was, “How better to see the costs and effects of the law and what needs to be changed or doesn’t than to have the person who wrote the law on your board.” This was not the first former member of Congress to join the bank’s board, however. Former Sen. Alfonse D’Amato has served on the board for ten years. So Signature has two former Banking Committee chairmen as directors. The Signature Bank founders, says Shay, want their board to be “a hot court”—a legal term meaning, where the judge asks lots of questions. “We want smart people,” says the Signature cha ir ma n. “ We don’t wa nt a potted plant. We want engaged, active members who can see risks and warn us off if they see a risk we missed.”
e don’t worry about W making ten extra basis points on yield or on loans. We have always been a sleep-at-night bank” – Scott Shay, chairman
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Don’t tell these 3 banks that new retail payments are only for the biggest banks
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he payments landscape keeps getting more interesting—and more uncer t a in. The init ia l release of Apple Pay in October 2014 created both excitement and worry in financial institutions. Was Apple Pay the payment mechanism we had all been waiting for? Would consumers f lock to mobile payments, ditching their plastic cards en masse? How would merchants react? Will followers Samsung Pay and Android Pay gain market share? The answers are: No; no; lukewarm; and likely. But then that could change next month. In addition to Apple Pay, other potentially disruptive payments landscape changes have taken place recently. And, like the month of March, some have come in like a lion and gone out like a lamb. The Oct. 1 EMV fraud liability shift for card-present counterfeit fraud losses came and went without a lot of fanfare. Others, such as virtual digital currencies created and held electronically, are attracting continued attention and even gaining momentum. With all the changes, it’s no wonder that small to midsize financial institutions hesitate to get involved. The larger ones are busy partnering with financial technolog y f irms to launch new payments products. They’ve invested in innovation labs and hired chief payment officers. Should smaller banks follow their lead? Banking Exchange spoke to bankers from three financial institutions to gain insight into payments strategies at nonmega banks: a $860 million-assets bank in the Midwest, a $1.3 billion-assets bank in central Pennsylvania, and a $26 billion-assets regional in Tennessee. A key point is that each banker interviewed strongly believes consumer payments play a critical role in his bank’s ability to attract and retain customers. These bankers are not sitting around waiting for the payments dust to settle. They have taken some proactive steps,
are exploring others, and, overall, are closely monitoring industry happenings. Here are their stories.
orrstown bank: bring on goliath
Unlike many smaller banks, Orrstown Bank believes it can—and should—compete against banks many times its size in the payments space, says Ben Wallace, executive vice-president of operations and technology at the $1.3 billion-assets bank. “Payments and transactional products, such as debit and credit cards, are critical, both as fee drivers and as part of our strategy to cement relationships with our customers,” says Wallace. Located in Shippensburg, Pa., less than an hour outside the state capital of Harrisburg, Orrstown Bank has a strong commercial banking legacy, but also tens of thousands of retail consumers “with cards in their hands,” says Wallace. Both Wallace and Chris Thompson, senior vice-president and chief architect, joined Orrstown from JP Morgan Chase, and are on a mission to ensure that the bank’s retail customers are as well served as the customers of their previous employer. Orrstown Bank prides itself on its customer relationships, so Wallace and Thompson set out to develop and support products that leverage and deepen those relationships. For example, the bank designed loyalty programs centered
Payments and transactional products are critical to helping cement Orrstown’s customer relationships, says Ben Wallace.
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By looking at the payment stream across all a customer’s products, we can personalize our conversation with the customer, setting us apart from the big banks” – chris thompson, Orrstown Bank
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Orrstown Bank is researching bankbr a nde d mobi le w a l le t s , a lt hou g h Wallace says that offering the wallet is still probably premature. So instead, the bank is focusing on building a foundation that will facilitate that offering when the time is right. “We’re reviewing our account structures, incentive programs, and our data analytics, so we’ll have the infrastructure in place to take advantage of payments innovations, including mobile wallet,” says Wallace. Another area of focus for Orrstown Bank is credit and debit cards. In addition to an of fering prov ided by Jack Henry, the bank has built its own fraud rev iew engine to perform geo-locate sec onda r y rev iew on c a rd tra nsa c tions. “We’re trying to think creatively around fraud platforms,” says Wallace. “How can we get more sophisticated to offer even more solid fraud protection to our customers?”
For example, Orrstown Bank’s opt-in service informs customers of purchases made via SMS text message and gives them the ability to confirm or decline purchases. Although many large banks offer such alerts, it’s less common at smaller institutions, notes Wallace. Orrstown Bank also is watching virtual currencies, with Wallace calling the approach “somewhat proactive.” Thompson ex plains that they have a sma ll segment of customers who use virtual currency for speculative investments, so the bank wants to monitor usage trends in case they need to incorporate virtual currencies into risk models. “We’ll be one step ahead,” says Thompson.
lincoln savings bank: active waiting
Micha el Mc C ra r y, L i nc ol n Sav i ng s Bank’s executive vice-president of e-commerce and emerging technology, says
Shutterstock/ xtock
around their demand deposit accounts, rewarding customers based on criteria like number and balances of additional accounts tied to their checking account. The bank also is working on accountlevel aggregation, so that a customer can view balances and transactions on both Orrstown and non-Orrstown accounts. “The customer can see their transactions, such as payments, across all their accounts,” explains Wallace, “and we see their behavior with non-Orrstown products. Visibility into customers’ payments and transaction behaviors is an opportunity to build on our relationship with the customer by offering additional products and services they may be interested in.” Thompson ex plains how v isibilit y works on a practical level. “By looking at the payment stream across all a customer’s products, we can personalize our conversation with the customer, setting us apart from the big banks.”
that although the payments landscape is still unsettled, it’s time to experiment. “We are a growing bank with a very impor tant retail presence. We want to prov ide these customers w ith the best and most secure technology,” says McCrary. “That means we’ve got to keep abreast of what is going on in payments.” Not too long ago it would have seemed surprising for a community bank to be so focused on innovative payments. Now, it’s another indication of the change rippling through the industry. While Lincoln Savings is still waiting to launch a mobile wallet, or even to issue EMV-enabled cards (more on why, below), it is actively looking at virtual currencies, all-in-one connected cards, and Apple Pay. The bank also is currently exploring all-in-one connected cards with Stratos, a financial technology firm in Ann Arbor, Mich. The card, which Stratos says is the industry’s first payment card that consolidates an unlimited number of payments and identification cards into one, is roughly the same size and weight as a standard credit card and has a builtin, non-rechargeable lithium ion battery w ith a two-year average life span. It allows consumers to carry credit, debit, loyalty, membership, and gift cards on a single card and works using standard magnetic-stripe readers. McCrary isn’t sure that an all-in-one card would actually disrupt consumer payments or be right for Lincoln Savings Bank, but it’s an interesting concept he’s investigating. McCrary also has his eye on virtual
currencies and talks to firms, such as Coinbase, that buy, sell, and use Bitcoin. But he is wary. “From a compliance standpoint, Bitcoin is terrifying,” he says. “It was originally designed to be used by people who want to be anonymous.” However, the technology underlying virtual currencies, called blockchains, is exciting. McCrary predicts that blockchain’s multiple points of replication will facilitate peer-to-peer payments delivery. Lincoln Sav ings Bank ha s not yet launched Apple Pay, although the bank will likely offer it in the near future as a positioning and branding strateg y. McCrary expects that the majority of the bank’s customer base will be slow to adopt mobile payments. “We’re in no rush to offer Apple Pay, but because it is so low cost, we may go through the steps to tokenize our payments cards, with the thought that we can use that tokenization for additional mobile payments offered by Samsung Pay and Android Pay,” when customers are ready, he explains. McCrary loves the idea of mobile wallets, but predicts that consumers will only find value once the wallets extend beyond payments and converge loyalty programs and membership cards that totally replace physical wallets. When asked if banks should invest in a bank-branded wallet or one from a provider like Google, McCrary suggests they offer both. “There is branding value in having our own wallet,” he says. “And we can ensure that our card is top-of-wallet.” The ba n k pla ns to roll out E M Venabled credit and debit cards, but did not feel the urgency to reissue cards before the Oct. 1 fraud liability shift. “Everyone started rushing to meet the October deadline, but when we thought about it, we found the deadline wasn’t as scary as it first sounded,” explains McCrary. “We are currently going through the steps to make our cards EMV-ready and will probably start reissuing them this year.”
first tennessee bank: a payments foundation
Lincoln Savings’ Michael McCrary is excited by blockchain. He predicts it will facilitate peer-to-peer payments.
Daniel Dent, senior vice-president, consumer deposit and emerging payments solutions manager for First Tennessee Bank, sees banking as a three-legged stool: deposits, loans, and payments. “Take away payments and your stool won’t stand,” says Dent. First Tennessee Bank, with $26 billion in assets, isn’t exactly small, but the bank
Payments is one of banks’ three primary “legs,” stresses First Tennessee’s Daniel Dent. Take it away and you fall.
knows it can’t compete directly with the mega banks in terms of scale in offering payments products. Dent is confident that a group of small, nimble banks— with the right partners—can provide innovative and personalized payments services that bigger competitors cannot. Dent has his eye on f inancial technology companies that can offer First Tennessee Bank a path to bank-supported payments products. For example, First Tennessee Bank is the bank of record for Social Money (recently bought by Q2 Holdings, Inc.), a financial services software company that offers apps like SmartyPig, a free online piggy bank for consumers saving for a specific goal. The bank offers Apple Pay, and even though the consumer adoption has been low across the industry, Dent believes that it’s important for banks to offer new technologies to differentiate themselves in the market. To encourage customer usage of Apple Pay and make sure its card becomes top-of-wallet, First Tennessee Bank has offered cash incentives. Mobile wallets are another area of interest. But rather than consider offering a bank-branded digital wallet, Dent is more inclined to work within an existing mobile wallet to move First Tennessee Bank’s card to top-of-wallet with loyalty and incentive programs. “I don’t think that investing in a mobile wallet, as a midsize bank, is the best use of resources right now, since consumers are still figuring out what wallet they will use,” he says. First Tennessee Bank ha s not yet invested in or devoted resources to February/March 2016
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We view payments as an important part of the banking ecosystem. Payments, deposits, and lending complement each other” virtual currencies, but that is an area it’s watching, particularly as it pertains to domestic and international regulations. The r eg ion a l of fer s s e ver a l c a r d products that the bank uses to deepen customer relationships. The Fast Funds Card is a reloadable, prepaid card marketed as a f inancial teaching tool to parents of teenagers. The card is not connected to a checking account, and is accepted anywhere Visa debit is accepted. It’s “a great way to teach teenagers about budgeting,” says Dent. “It also allows parents to monitor spending activity.” The cards have been so popular with some customers, he says, that teenagers continue to use the cards into adulthood. Several years ago, the bank started offering affinity debit cards logoed with University of Tennessee mascot Smokey, University of Memphis’ Tom the Tiger, and the Memphis Grizzlies’ basketball team. Spurred by their success, First Tennessee Bank expanded its line to include premium debit cards. For $8, customers can select from a variety of designs associated 24
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with sports, hobbies, the military, and even their favorite Tennessee city. In 2016, the bank will roll out debit cards associated with a to-be-named nonprofit. The bank will donate any fees charged directly to the nonprofit. “These cards are a way for customers to show what they are passionate about,” says Dent. “Not only do we expect that this new card will attract customers, but it’s a positive way for us to increase charitable contributions in our community.”
“be on the field”
These bankers are optimistic about the role of payments in their institutions. And they aren’t discouraged by a constantly changing payments landscape or the deep technology budgets of their much larger competitors. “If small and midsize banks say they can’t play in consumer payments, I would ask them why they would want to give up the leverage payments gives them to grow deposits or their lending portfolio,” says Wallace of Orrstown Bank. “We view
payments as an important part of the banking ecosystem. Payments, deposits, and lending complement each other, if you are smart about it.” Dent agrees: “Payments is very important to how we do business, especially with fewer customers coming into our branches. We need to have dif ferent channels for customers to access their money and make payments, both as a differentiator and a way to deliver a great customer experience.” He adds: “You may not have to rush out and offer innovative payments right now, but you absolutely need to be looking at these technologies. You need to be on the field.” McCrary doesn’t know if any of the pay ments technolog ies that Lincoln Savings Bank is looking at and experim e n t i ng w i t h w i l l h a v e l e g s w i t h consumers. But he’s not t a k ing a ny chances. He offers this advice to other bankers: “It’s not too early in payments to get involved. Just educate yourself, and be ready to jump when the time is right.”
Shutterstock/ pulsar011
– Ben wallace, orrstown bank
/ risk adjusted /
fasb’s great expectations
Bankers object to controversial ALLL “expected loss” proposal, but need to prepare in case it stays By Steve Cocheo, executive editor
I
f every loan made were repaid as promised and scheduled, the allowance for loan and lease losses wouldn’t be necessary. But because that’s not real life, banks must quarterly add or subtract from the ALLL—also referred to as loan loss reserves—to ensure that there is some cushion. The rub lies in how much to set aside and when. And that’s behind the controversy over the Financial Accounting Standards Board’s pending adoption of the “expected loss” model—“Current Expected Credit Loss” or CECL—which is replacing the incurred-loss model currently in place. “We expect the adoption of CECL to be a major change for the banking industry,” notes Keefe, Bruyette & Woods in a late 2015 report. Regulators have gone further, calling CECL “the biggest change ever to bank accounting.”
Backers say implementation will leave banks Supporters, opponents duel better prepared for downturns; opponents stress Backers of the rule, which evolved over it will be expensive and make bank reports opaque several years since the financial crisis, think the final version, due early in 2016, will be a more timely and accurate means of setting ALLL. Among their claims are that adoption of CECL will leave banks better prepared for a major downturn. They believe that the industry went into the Great Recession with insufficient reserves. Banking representatives and others dispute this. Opponents of the measure believe it w ill br ing no sig nif icant benef it , cause greater volatility in bank financial reporting, and be very expensive, if not unworkable or unrealistic, for community banks and even midsize banks to implement. Some also say that bank reports will become less comparable one to another—potentially meaning that for all the effort and expense, less light and less transparency will result for users of financial statements. I n e a r l y Fe b r u a r y, a k e y pu bl i c roundtable was held by FASB, where representatives of the American Bankers Association, the Independent Community Bankers of America, and bankers
from smaller banks met with FASB board members and staff concerning CECL in concept and in implementation by smaller banks. (Regulators and accounti ng i n du s t r y r e pr e s e nt a t i v e s a l s o participated.) Meanwhile, FASB staff has been at work finalizing the rule, which at press time was expected to be mandatory for SEC registrant companies in 2019 and for other organizations in 2020. Writing in advance of the FASB roundtable, community bank attorney Jeff Gerrish blogged about the concept on www.BankingExchange.com: “I personally hope [FASB] gains some ‘perspective’ (translated: ‘common sense’) prior to that time and exempts community banks from CECL compliance.” While such a development is rare, it is not without precedent. News reports indicated that while individual bankers at the roundtable felt some progress had been made, the two associations were not satisfied by what they heard. “FASB’s complex accounting proposal
would radically change community bank accounting methods, sharply increasing the cost of lending and constricting the f low of credit to local communities,” ICBA said in a statement to the FASB board. The association issued a statement headlined: “Hit Stop Button On Dangerous Accounting Plan.” ABA’s Michael Gullette, vice-president for accounting and financial management, said in a statement that too much of the CECL roundtable concerned issues resolved some time ago or that were not part of the controversial concept. “As a result, little substantial discussion was given to the underlying source of complexity in the CECL model,” he noted. He said ABA would be reaching out to FASB, auditors, and regulators separately.
Don’t wait; prepare now Indeed, CECL’s complexity has prompted ABA to advise bankers at institutions of all sizes to begin preparing as early as possible for the shif t, even as the February/March 2016
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/ Risk Adjusted / industry groups still press for changes. “It’s sor t of like enter ing the lottery,” says Donna Fisher, ABA’s senior vice-president of tax, accounting, and financial management, in an interview. “You buy your ticket, but you don’t quit your job. You have to assume that CECL’s going to take effect.” ABA plans a series of educational efforts to help banks to prepare. Fisher and Gullette say that many policy, systems, and vendor issues must be addressed, and this can’t be started too soon. Large institutions certainly will go ahead. Midsize banks may have the greatest difficulty, says banking investor Joshua Siegel. He explains that the largest banks already deal with reserve issues over a broad canvas, both national and international in scope. (Siegel serves as chairman and CEO at StoneCastle Financial Corp.) The midsize institutions, Siegel continues, will have much more to get their arms around to comply, in terms of research and computations. Community banks, though not set up for extensive data-gathering and analysis, work on a much smaller, local stage,
according to Siegel. ABA notes in a white paper, however, that smaller banks have already told FASB that estimating losses more than a year or two out is difficult for them. There is no sweet spot, really, but Siegel maintains that CECL will be “a very complicated issue as banks get larger.” Even the largest banks will face a lot of lower-level internal proposals on what is appropriate, and this will filter all the way up to one official, who must rationalize things to one yardstick—about which Siegel says, “Good luck!”
FASB’s life-of-loan concept Setting up and monitoring the ALLL has been an essential element of bank risk management even before the industry began using the latter term. Reserves also have been controversial, at times the subject of a tug-of-war between an SEC concerned about “earnings management”—a lleged usage of reser ve levels to control perceptions of the bottom line—and the regulators’ insistence that recognition of diff iculties be timely. Reserves also are something a na ly st s wat ch when pa r sing ba n k
“Bank disclosure about expected life-of-loan loss assumption will be key; expectations for quality disclosures, however, are low” —Keefe, Bruyette & Woods
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earnings—i.e. the percentage coming from ongoing operations versus from releasing reserves. The evolution that resulted in CECL was full of twists and turns. FASB had weighed multiple potentia l models, including one that would have been in concert with international accounting rulemakers. ABA and ICBA each had their own counterproposals to accommodate change without going fully down FASB’s anticipated road. At present, banks comply with the principle of “incurred loss” for setting loan loss reserves. That is, in the simplest terms, if an event has happened that w ill cause a loan to go bad, the bank must weigh the matter and adjust reserves accordingly. CECL would be very different. Essentially, when a loan is booked, a bank would have to determine up front what the ex pec ted losses over the life of the loan could be. The reserves decision is always meant to be deliberative, but such a life-of-loan approach would require a much higher reliance on histor ic a l data w ith which to forec a st expected losses, which would then be
used to set the ALLL. Auditors would evaluate a bank’s process for establishing reserve amounts. As ABA explains in a white paper, “A credit loss provision (expense) is recorded effectively at the time of loan origination based on what is expected to happen many years in the future. In practice, loss estimates for both models (incurred loss and expected loss) will normally be performed in pools (not individually), using historical experience as a starting point. Adjustments are then required to finetune historical averages and arrive at an actual estimate of losses at the reporting date (incurred model) or to the end of the loan’s expected life (CECL).” Ultimately, the industry’s objection to CECL lies in the concept itself. “It’s not the way that banks look at risk,” explains ABA’s Fisher. Fisher’s associate, Gullette, uses commercial real estate loans as an example of what banks face. CRE credit is cyclical, and a portfolio, historically, may see a decade with low or no losses, followed by a year of high losses. “How do you work with your auditors and regulators on this when you are not expecting losses most of the time?” questions Gullette. Fisher notes that some portfolios, such as credit cards, consisting of relatively homogenous credit, lend themselves better to portfolio-level evaluation and projection. But CRE and other commercial loans tend to be more specific and individual in nature, even in one market. Gullette says that regulators have a ssured the industr y that they w ill work to make application of CECL “scaleable”—appropriate to the size and sophistication of the bank. Much will only become apparent once CECL is out of the barn, and Gullette says that the industry, auditors, and regulators “will be fumbling around for a couple of years.” A FASB transition group, including banking industry representation, has already been established. “Complexity is the name of the game here,” says Gullette. Fisher says a major concern for smaller banks is a lack of databases that they can use for estimating life-of-loan losses. It’s expected that community banks will have to spend more on staff and related costs to make CECL work—something ABA and ICBA believe will put them at competitive disadvantage.
Prepare now. “Current Expected Credit Loss” will replace “incurred loss.” FASB promises scaleability, but all size banks must start addressing policy, systems, and vendor issues Apples, oranges, carrots?
Arguments that something like CECL would have prevented the financial crisis “are pretty much an illusion,” according to Gullette. Inasmuch as any question of prevention is more or less moot and unprovable, looking ahead makes more sense: What impact would the transition have on reser ve levels, as CECL is currently understood? Estimates var y w ildly, hinging on the economic outlook of the estimator and more. Ba n k s a nd their aud itors w ill be conferring a great deal about what’s acceptable. “The standard is really about what your individual expectations are, and how you support those,” explains Gullette. “There is the basis here for a lot of confusion, and no one has given that a lot of thought.” While the transition group is in place, ABA would like to see many issues resolved before the standard is finalized. Even then, all banks will be adding more variables to their deliberations over ALLL, as they project life-of-loan losses. In a table assessing the impact of CECL, Keefe, Bruyette & Woods states: “Comparability of f inancial results will be reduced both historically and between companies due to the variation of loss accounting methodologies likely to be allowed. Bank disclosure about expected loss assumptions will be a key, but expectations for quality disclosures are low.” It also points out that management philosophies will drive more of the decision, “since a wider latitude will be given to managements to assess potential reserve requirements, and a wider possible range of outcomes could result.” Here lies a fundamental concern for Siegel, who as a bank investor is a user of the financial statements that will result from a new take on ALLL. Indeed, part of FASB’s stated rationale for CECL is that investors want an expected loss model. Yet Siegel, experienced with FASB deliberations, is no fa n of CECL at all. With all the variation that can go
on behind the scenes, he sees CECL resulting in less transparency and less comparability, so there will be more confusion, not less. C onc ept ua l ly, he poi nt s out t hat FASB is meant to be the arbiter of what GAAP—“generally accepted accounting principles”—are. Yet Siegel sees CECL driving more variation, and without seeing everything that went into the reserves decision, investors will have less to go on, not more. There will be less “generally” in GAAP in this regard, he says. Siegel says there is a point of confusion in the rationale behind CECL in that it derives, in part, from the view of structured securities, which are constructed on a standalone basis. Reserves are built into those as a result. He says that what FASB fails to understand is that banks have the f lexibility that securities do not. Banks can retain their earnings and add to their capital outside of the ALLL process. “ That seems to be lost on FA SB,” points out Siegel, and so a whole new approach to reserves is being adopted. And banks are already under revised capital standards. A s a n investor, Siegel sees CECL as a poor bargain. Potentially, higher reserves will be set, which will idle more resources. Additional money w ill be spent to support reserve decisions. “Will CECL make the banking system safer?” asks Siegel. “Yes. But it will make it almost too safe.” And that will be only marginally, while lowering potential earnings, he adds. More immediately, FASB is supposed to be weighing the cost-benefit balance of CECL. Gullette asks, “Without there being a common understanding of what CECL requires, how can FASB do an adequate cost-benefit test?” Once CECL is out of the gate, there may be no choice. In its white paper, ABA states that “even if CECL welcomes the use of simple estimation models, a relatively complex model will be required to satisfy auditor demands.” February/March 2016
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/ BANK TECH /
Core conversion . . . Oh no! It’s a big step, but increasingly necessary. Busey Bank takes the plunge By John Ginovsky, contributing editor
Ill., determined in 2012, just as it was reevaluating the contract with its previous core system provider. “We started examining the service levels that we were getting from them and also, of course, the expense side of it,” says Howard Mooney, executive vice-president and CIO at the bank. “Mostly, we were factoring in some of the changes to the environment that we saw coming our way in terms of what the market demands were going to be from a competitive perspective, and also, more importantly, our clients’ perspective.” Mooney also is president and CEO of FirsTech, Inc., the bank’s payments processing subsidiary. The bank had an added motivator in that its previous contract was reaching its end date, meaning the bank had to make a quick decision. It decided to switch to Computer Services, Inc., (CSI), which Busey Bank knew from some of the acquisitions it had made. The vendor’s service level and f lexibility in those earlier conversions, says Mooney, “as far as integrating and helping us drive the strategy that we had outlined for ourselves, as opposed to basically pushing products, were key factors in determining that it made sense for us to make a change.”
T
he onset of new technologies have changed customer expectations, and lagging capabilities of legacy core banking systems are driving banks to consider the ultimate upgrade—complete core conversion. For many banks, the solution, so far, has been to update existing systems with new add-ons that bridge the gaps in capabilities. But new demands for technologies—among them digital banking, mobile access, omnichannel consistency, additional lines of business to boost revenue, as well as the sustainability of the bank overall—have ramped up the urgency of making fundamental changes in the back office. “Over the last ten years or so, vendors have been really good at creating middleware layers to connect these new modern services without having to touch the back
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end,” says Stephen Greer, an analyst at Celent, who has studied bank core conversions. Nevertheless, he adds: “There will come a time when [legacy] core systems won’t be able to keep up with the demand for modern real-time digital channels or digital banking.” In fact, that time may be at hand. Greer says that based on the last couple of years of sales reports, core conversion deals are starting to increase slightly, year-over-year.
The time had come The best core system conversion—in terms of fitting in with the unique nature of a financial institution’s strategy, reach, and operations—will not come off a shelf. To achieve that level of fit requires a close relationship between bank and provider. That’s what Busey Bank, a $4 billionasset institution based in Champaign,
Five-month conversion The bank converted almost everything, Mooney says: Core, loans, checking, savings, CDs, general ledger, document storage, check storage, remote deposit capture, item capture, branch capture, wire systems, teller systems, account systems, reporting systems. “The consumer digital platform remained the same,” says Mooney. “The business digital platform was consolidated from two systems to one, which was happening prior to the bank core conversion. The core conversion pushed forward the timetable.” Perhaps most a ma zing, t he ba n k did the complete conversion, due to contractual obligations, in just f ive months—impressive for a bank this size, g iven the scope of the change. Mooney says it required a close working
“This was the most aggressive time line I’ve ever been a part of. I wouldn’t necessarily recommend it. . . . The result was positive. We haven’t looked back” – Howard Mooney, CIO, Busey Bank relationship with the vendor. He calls it an “all-hands-on-deck approach” for both the bank and CSI. “This was the most aggressive time line I’ve ever been a part of. I wouldn’t necessarily recommend it, and I’m sure CSI wouldn’t either. But we were put in a situation where we really didn’t have a choice. So that’s what we did. Everybody really came together on it. In the end, the result was positive. We haven’t really looked back since,” he says. (A normal time frame for conversion, according to Mooney, would be a minimum of nine months.) Mooney emphasizes the need to match what the bank wants and needs with what a vendor can adjust to, in order to achieve a successful core conversion. “We support multiple lines of business. We have a large retail operation, but we also have a commercial and wealth management focus. And we have a payment processing subsidiary, too, that handles about 25 million payment transactions a year,” he says. “When we start looking at all of those various lines of business and the supporting banking structure that allows us to continue to grow in those areas,” continues Mooney, “[we] really look for best-of-breed type of products. In some
cases, we develop some of our own platforms and systems. Flexibility, ease of integration, and willingness of integration were critical for us.” How did the conversion affect Busey’s IT department? The number of tech vendors the bank uses has remained about the same. It has either replaced vendors with those that offer more compatible services with CSI or brought processes in-house. “Our thought process for bringing processes in-house was that we would work with CSI on future enhancements to automate those processes,” explains Mooney. Also, the bank’s IT staffing levels did not change, he says, though he notes that resources have been added “to support our ongoing growth and security demands.” As for IT spending: “We were able to realize some initial savings as a result of bundled pricing for multiple products, but service was our primary driver for change,” he adds.
No major disruptions The biggest challenge to core conversions is the potential to disrupt services to customers. Celent’s Greer says in a recent report that “the process of switching out a core system has been likened to changing the engine on an aircraft in flight.” For Busey, conversion happened “99%
behind the scenes,” Mooney says. “We did not have major customer disruptions. We have a lot of very large clients that expect things to work and work regularly, and not give them a lot of issues. We were able to pull that off.” The upgraded system has helped the bank improve satisfaction, shown by surveys conducted through the organization Net Promoter (www.netpromoter.com). (Essentially, this company asks customers to rank satisfaction from one to ten. Those who give ranks of nine or ten are termed “promoters,” while those who give ranks of zero to six are “detractors,” the difference being the Net Promoter Score.) Busey Bank saw its NPS rise from 25 in 2014 to 31.5 in 2015. “We v iew the success or the effectiveness of this k ind of move [core conversion] not only through the efficiencies and those types of things that we gain, but also through the lens of our customers,” Mooney says.
Service, not fads Looking forward, Mooney says the core conversion has positioned it well in terms of meeting new demands, new opportunities for fee income and revenue streams, and overall bank sustainability. However, he cautions against adopting new things simply because they are new. “For us, we have to be able to move fairly quickly when we need to. But we also are very wary of chasing the fads,” he says. “We use our vendor relationships to help us determine reliable, risk-averse technology.” As always, nothing ever goes away in banking, like paper checks and lock-box operations. “Those legacy platforms are very important. . . . We certainly didn’t abandon those,” Mooney says. Still, he says, Busey’s core conversion was necessary: “From a service perspective and from our ability to deliver the best options to our clients—based on our market, based on our lines of business— I’m confident that had we not made that core conversion, we would not be in as good a position as we are today.” February/March 2016 BANKING EXCHANGE
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/ Idea Exchange /
BIRTHDAY-based funding shift
125th anniversary helps N.H. bank move from wholesale borrowings to cheaper retail funding By Steve Cocheo, executive editor time now—Brannen says that management knew it couldn’t rely on the cheap short-term money forever. Plans were formulated for laddering this funding out in longer-term forms available from the home loan bank, to preserve some of the lower-rate advantage. That is, plans were made, but “we held off as long as we dared,” says Brannen. Management kept watch on the pulse of its asset-liability mix and on the Fed, with the assistance of Darling Consulting Group advisors, and, with the central bank continuing to hold off, benefited from several years of a continuing lower cost of funds with resulting better margins. (Of course the Federal Reserve did wind up making a slight increase late last year.) Last spring, as the likelihood of a Fed rate increase began to look more and more certain, the bank began to get ready to activate the laddering plan to extend the terms of its borrowing. Meanwhile, the consulting firm began running simulations to see how the bank’s nonmaturity deposits would behave with a rate hike. Then the bank and its consultants began to wonder if Federal Savings could replace the borrowings with cheaper deposits. Some experimentation with various offers occurred, and then the bank spotted a unique opportunity: The bank was turning 125 in 2015.
Happy 1.25% birthday
F
or much of its recent histor y, $301.3 million-assets Federal Savings Bank of Dover, N.H., has been a different kind of small thrift than the usual. It had been running loan-to-deposit ratios much higher than 100%—typically in the general area of 120%, give or take—as it enjoyed a steady state of asset growth. In recent years, as the New Hampshire seacoast community enjoyed growing prosperity and an influx of new banking brands anxious to grab a share of that, it had sat out the accompanying battle for local deposits.
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“We hadn’t been a player,” explains James Brannen, executive vice-president and CFO. The bank had held onto the deposits it had, through the loyalty of a long-term customer base, but decided to stay out of the bidding war. Instead, the bank did a great deal of wholesa le bor row ing f rom the Federal Home Loan Bank of Boston, using short-term, low-rate borrowings to fund its growing loan base. With talk going back several years now of an “impending” Federal Reserve rate increase—regulators have been warning of the risk of rising rates for a long, long
Federal Savings began scouting around for what local and regional competitors were paying for deposits and realized that a money market deposit account offer priced at 1.25% APY, tied to the bank’s anniversary, would be very attractive and also cheaper than where the blended rate of the laddered borrowings would amount to. The bank launched the offer in later June, promoting it through print and radio ads as well as social media channels. New customers who brought in a minimum of $75,000 for their MMDA could receive the special rate, and existing customers could qua lif y if they
brought in $25,000 in new money. The results were stunning. The special MMDA offer appealed to savers—only retail customers were eligible—and the “Milestone Money Market Account” brought in $22 million in new funds, according to Kelly Glennon, vice-president of risk management and retail banking. Glennon says that the offer brought in $145,000, on average, in new money from existing customers. In addition, among the new customers, 78% signed up for ancillary services when they opened their new deposit accounts. And nearly half of the accounts opened under the MMDA promotion represented customers who were new. This worked well towards the bank’s strategy of replacing wholesale borrowings, but its success didn’t stop there. To attract longer-term funding, the bank doubled the offered rate to 2.50% APY for a five-year CD or IR A, with a minimum deposit of $1,000. This offer brought in $12.1 million in new funds. “Our timing was good,” says Brannen. “We found that retail customers were growing frustrated, waiting for deposit interest rates to rise. And our competitors weren’t as hungr y because they weren’t as liability-sensitive as we are.” Brannen estimates that the bank will wind up saving 22-40 basis points by shifting over to deposits, raised through the dual offers, instead of going with the laddered borrowings. “This has materially improved our interest rate position,” says Brannen. Wholesale borrowings were cut in half, even as the bank’s high loan-to-deposit ratio, w ith continuing asset grow th, held steady.
Burning up shoe leather Glennon says that the bank took the deposit offer and the anniversary as an opportunity to reemphasize the local bank’s connection to its market, which had seen so many new, competitive brands encroaching to take advantage of seacoast prosperity. The city of Dover declared June 26th
“Federa l Sav ings Bank Day,” which helped put the bank on the local calendar. The bank marked the day with festivities including a free lunch provided at the Dover branch by a food truck and free dessert, coming from an ice cream truck. Prize drawings were held, including one for an Apple Watch. The bank had already been planning to increase its live customer calls, and this was emphasized with a “feet on the street” day. A team of Federal Savings bankers fanned out through the bank’s market and made 125 sales calls to promote the two higher-rate deposit offerings. Glennon says the outreach was quite effective, accounting for a good share of the offers’ success.
Keeping the money Of course, it is one thing to bring in deposits. The challenge is to keep customers in the bank. Federal Savings has been taking steps to improve its appeal to the community. One step is remodeling branches, for a more consultative format. The bank’s offerings are increasingly electronic, but management is convinced that branches remain important. “Customers still need a place to come and beef to, if something goes wrong,” Brannen says. “And even if they don’t come to the branches that often, they want to know those faces at their branch.” The shift in branch style is intended to demonstrate that the bank remains current, even as it proudly points to 125 years of local history. There is a stronger emphasis on sales. “We want to make sure we have a presence on the streets,” says Brannen. So the bank has put together a sales group of calling officers led by a sales director, to increase familiarity with the bank. A sales lead and referral system has also been put in place. This builds on a strong base. “We have tremendous loyalty and this will hold us in good stead going forward,” says Brannen. “Our nonmatur it y deposits consistently show a stickiness.”
A shift in funding strategy “materially improved our interest rate position,” says James Brannen, CFO, Federal Savings Bank. The bank moved towards more retail-based funding.
Mass media and social media played a part in promoting the bank’s deposit push, but Kelly Glennon, vice-president of risk management and retail banking, says banker calls played a big role in the bank’s success. February/March 2016
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/ Compliance Watch /
Fair Banking on the Rise
It combines elements of fair lending, UDAAP, even complaints, and puts more emphasis on outcomes By Steve Cocheo, executive editor
V
isit LinkedIn, and enter the term “fair banking.” You will find something you wouldn’t have fou nd f ive ye a r s a go: pages of bank officers with titles like director, fair banking; fair banking compliance manager; and other variations. While many of the bankers bearing some version of the title work for very large banks, not all do. And even where the banker’s title doesn’t include fair banking, chances are the phrase will appear in the job description. And, by the way, the term is making its way into the titles, job descriptions, and
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organizational names for activists who are targeting banks. Indeed, the only place you won’t find fair banking is the Consumer Financial Protection Bureau’s org chart—though it still includes the narrower “fair lending.”
Roots of “fair” The term fair banking has been ushered in, in part, by the expansion under the Dodd-Frank Act of UDAP to UDAAP— prohibition of unfa ir, deceptive, or abusive acts or practices. CFPB has done little to f lesh out the industry’s understanding of the term
“abusive,” leaving banks to attempt to read the tea leaves to divine what is and isn’t appropriate. While some bankers have been known to use their own “smell test” for new products and services or new policies, “fair” can be subjective. Last fall, during a panel discussion on fair banking at the CR A & Fair Lending Colloquium, presented by Wolters Kluwer Financial Services, moderator Lynn Woosley asked panelists how they assessed “fairness risk.” (She is senior vice-president and fair and responsible banking officer at SunTrust Banks.) Mark Schultz, senior director for fair lending compliance at Capital One, said that the company formerly provided a nonnumerical tool to staff for making such judgments, but found that it didn’t work well. “I don’t think there is any one person who can make the right call regarding what’s fair,” said Schultz. According to Schultz, today the two main parts of the bank overseeing fairness overall are Legal and Compliance. The bank looks to Legal, he said, for identification of what’s fair or not, and looks to Compliance to be the bank’s “eyes and ears.” The idea is that Compliance escalates risk issues that it identifies. Jeff Jaffee, senior vice-president and senior corporate compliance manager at Bank of the West, said that the bank reviews fairness risk on a product-byproduct basis. Each one receives a risk assessment, and the staff works to mitigate those posing the greatest threats. This review must go beyond product features, as a problem could result, for example, from marketing that targets a vulnerable population, such as students or seniors. Complaints can be a good place to find potential issues, said Jaffee. “They are a good source for things that customers feel are unfair.” Woosley said that anytime a change is made in a product or service, SunTrust Banks reassesses that specific item in case the change turns a fair relationship into an unfair one.
“Fair” and lines of defense
Each of the banks represented on the panel have adopted the “three lines of defense” approach to compliance and risk management. Typically in this approach, the business unit is considered the first bastion against risk, and this applies to fair banking risk as well. “We expect business units to own both their risks as well as the management and mitigation of those risks,” said SunTrust’s Woosley. However, her own unit handles regression analysis—used to analyze the potential or existence of differential treatment or impact. This, in part, is so that the function can be centralized, she explained. It’s similar at Capital One. “We expect the business units to be educated regarding what their risks are, and we expect them to consider those risks,” explained Schultz. Each business line has a governance committee with which Schultz works closely. At Capital One, he pointed out, the classical compliance responsibilities have been pushed out to the first line, the business unit. The only exception, as at SunTrust, is monitoring and statistical analysis. With CFPB making complaints a bigger part of regulatory activity than ever, bankers increasingly have been regarding complaints brought straight to them
as a resource to be mined for problems and direction toward solutions. Jaffee said that common problems and root causes can be identified when complaints handling is centralized, and this enables action. “Over the last year or so, we have changed both policies and procedures w ith our line-of-business par tners,”
the liquor store would cash. His father would then go to the hometown bank to cover the check. Together, they were relying on float. “If you told my story to a 20-something today, they’d look at you as if you were crazy,” said Jaffee. “The world has changed.” His point is, have banks’ policies and practices changed? Even if
While some bankers have been known to use their own “smell test” for new products, services, or policies, “fair” can be subjective noted Jaffee. “They are the first line of defense, so they own it.”
“Fair” and banking spread
The panelists agreed that the challenge of determining what is fair is growing, in part, because of the rapid pace of change in banking. Pointing to the industry’s practices on deposit funds availability, Jaffee talked about his college days. There were no AT Ms, no debit cards, no apps. His school actually recommended a local liquor store, which would cash a check for free—if you used part of it to buy beer. Jaffee said he’d let his father know he needed money and write a check, which
regulations haven’t shifted, disclosures and policies need to be considered in light of current conditions and technologies. To underscore the impor t a nce of continually reexamining policies and practices in this light, Jaffee pointed to the Citizens settlement of August 2015. Citizens Financial Group, Inc., and affiliates agreed to pay $31.5 million—$11 million in refunds and $20.5 million in civil money penalties assessed by three agencies—for failing to credit full deposit amounts. The joint CPFB, OCC, and FDIC settlement accused the company of unfair and deceptive practices—specifically, keeping money from deposit discrepancies when receipts didn’t match
Read what auto dealers read and you won’t be blindsided Why would a compliance officer subscribe to Auto Finance News? Consider for a moment two stories on the publication website’s front page recently: a description of how one non-bank finance firm tries to cross sell credit cards to subprime auto borrowers and tips on collecting from millennials (make it fun; use gamification to keep payments on time). Bank of the West’s Jef f Jaf fee subscribes and recommended doing so to the recent CRA & Fair Lending Colloquium audience, because Auto Finance News’ print newsletter and website are where auto dealers go to share what they are doing to make more money. “Whatever they are thinking of has got to get you worried,” said Jaffee. The banker spoke of the various complicating
factors that go into an auto financing transaction, and noted that an Auto Finance News article he’d seen suggested how to crank up a purchaser’s loan-to-value ratio to 137%. “That doesn’t sound like a good number to me,” said Jaffee. Auto loan terms have Jaf fee concerned as well, with some going as long as 84 months—seven years. “I know cars last a long time,” said Jaffee, “But that’s something to be really careful about.”
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/ Compliance Watch / actual money transferred. The agencies’ statement indicates the discrepancies were not addressed if they fell below a particular threshold (first $50; later $25). Over a period of almost five years, this alleged behavior amounted to millions in shorted deposits, the agencies said.
Overdrafts: We’re all struggling With overdraft protection—which CFPB has had in its sights from its beginnings—banks must be certain that their programs do what they say they do. “You really need to be on top of it,” said Bank of the West’s Jaffee. He indicated that CFPB expects to see such correlation. Panelists warned that the bureau looks askance at an institution that has what it perceives as too many opt-ins to overdraft service. Jaffee said it is essential for frontline staff to be sure consumers are clear what they are signing up for. He added that it would be instructive for compliance officers to review how much of the bank’s income came from over-
exposures. It’s possible for exciting technology to get ahead of compliance and fairness thinking. “If you are only offering certain features of products through your bank’s app, you have to be sure you aren’t creating an impact based on that,” said Capital One’s Schultz. “You have to be looking at these things through a fair-lending perspective.” For example, discount coupons that are only available to app users could wind up triggering a compliance problem if certain groups tend to obtain benefits that others don’t. There’s also the issue of disclosures. “If you are making loans over a mobile phone, will you be able to make required disclosures in a clear way,” questioned Schultz, “so people know what they are getting into?” Woosley pointed out that consumers notoriously don’t like to have to “click” a lot to get anywhere. As a result, she suggested bankers place disclosures as close as possible to borrowing points, to
Banks must be certain their programs do what they say they do, and be mindful of compliance and fairness thinking with new technologies draft charges and other service fees—the implication being that leaning too hard on this could be a red flag to examiners. A similar challenge is serving people who don’t speak English. “There’s a balancing between fair lending risk and UDAAP risk,” said Woosley. Moving the dial either way can expose a bank. Legally, Schultz said, the easiest option is doing business solely in English, but that will not help the bank offer broad service. However, once a bank ventures to offer service in other languages, that forms an expectation that documents— at least significant disclosures and other key ones—be produced in translated form. And to avoid issues, those documents must be accurately translated. “This is probably one of the biggest fair lending/UDA AP concerns of the moment,” said Jaffee. “We’re all struggling with what the right thing is to do.”
Digital advances, a challenge While banks run risks if they don’t keep up with technology, panelists agreed that keeping up comes loaded with its own
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minimize necessary navigation. Schultz noted that any bank either partnering with, or adopting the methods of, an online marketplace lender must be sure that all compliance requirements are observed by all parties.
Avoiding “add-on” problems One of the regulators’ targets in UDAP and UDAAP cases has been products and services added onto other ones, such as protective services added to credit cards. Schultz said there is room for disagreement about the utility of such products. As a parallel, he noted that he and his father differed on the need for extended warranties; his parents generally opting for them, and he typically avoiding them. That said, Schultz said it was important for add-on products have some true value to customers, and that costs, coverage, and more be disclosed clearly and accurately. Product is important as well, so that the add-on services provide what is promised. Additionally, sales efforts must be scrutinized. Schultz said that Capital
One’s compliance function tests sales letters and monitors phone calls to be sure that any add-on products are sold in an appropriate fashion. “And then you have to make sure that they don’t go offscript,” warned Schultz.
Where are auto dealers heading? When banks buy indirect paper from auto dealers, they inherit any and all compliance issues. There is no safe harbor, because the dealers act in the bank lender’s stead. Thus, all three banker speakers said their institutions have grown more hardnosed in the wake of recent enforcement settlements, insisting on delving into records to be sure that UDA A P and other violations are not occurring. “When I started asking, ‘What’s in the black box?,’ they looked at me like I’d lost my mind,” said Woosley, referring to dealer credit evaluation processes. Not all dealers will share everything, but will often share more than they first offer. “They are getting more people asking for more information,” Woosley said, “but it is still a negotiation. Some will say, ‘We won’t give you the secret sauce recipe, but we will give you the results of our disparate impact testing.’” She said she’d grown comfortable with that. Jaffee stressed that bankers should not be put off by auto dealer resistance: “Don’t be shy if they say anything you ask is an outrageous request.” “Different banks will be in different positions of leverage with their dealers,” Schultz acknowledged. Third-party partners of any stripe pose compliance and fair-banking risks for banks, whether the relationship involves credit, fee income, or otherwise. An audience member asked Woosley if more banks were stiffening contract language with partners in response to UDA AP and other fair banking risks. Woosley cautioned listeners against regarding contracts as complete protection, but said they were valuable in that they could ensure that banks maintain oversight and monitoring access to their partners’ activities. Schultz noted that a number of Capital One’s contracts grant the bank auditing rights. In typical practice, this isn’t always done on site, but the ability to do so is frequently arranged. Should the bank need maximum access, the opportunity is there.
/ Ad index /
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Comcast Business
888-317-9627
business.comcast.com/financial-services C4
CPI Card Group
307-248-0255
klawton@cpicardgroup.com
www.cpicardgroup.com
C2
DCI (Data Center Inc)
620-694-6800
info@datacenterinc.com
www.datacenterinc.com
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The Advertisers Index is an editorial feature maintained for the convenience of readers. It is not part of the advertiser contract and Banking Exchange assumes no responsibility for the correctness.
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February/March 2016
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/ CounterIntuitive /
WHO’S THE BEST?
When it comes to customers, the answer to that question is all over the place By Chris Nichols
U
nfortunately, most banks either have no idea who their best customers are or, worse, think they know, but can’t agree on what “good” customers look like. And if a bank, internally, can’t agree, then how can it ever expect to find more? Some may say, “Profitable customers are good customers, obviously.” Yet others may say that customers whose only profitability lies in the net between their deposit interest return and loan interest payments are less than the best. Fol low i ng a re a mong one ba n k ’s employee responses to: “Who would be ‘good’ customers?” • Those who maintain their primary relationship with you. • Those who have their primary business account with you. • Those who have their primary business account with you and have the desire to take their company public. • Those who generate an annual profit and have the same core values as you. • Those who have subscribed to five different products in the last six months. • Those who have loan outstandings in your top 10%. • Those who have deposit balances in your top 30%. • Those who have non-interest deposit balances in your top 25%. • Those who keep their primary account at another bank, but generate ten-plus referrals per year (like an accountant or law firm). The desired green line of bank customers
Profitability
graphFACT
Number of profitable customer attributes
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• Those who generate risk-adjusted ROE in the top 25%. • Those who have a lifetime value in your top 25%. If you feel everyone listed could be good, you may be right, but that’s a problem. If you say, “I don’t care as long as everyone is profitable,” that’s an even bigger problem. That attitude will surely inhibit your understanding and likely result in less profitable customers, not more. All could be good customers, and all could be profitable customers. The question is: Which ones do you want? Each customer type is different in profile, motivation, and persona. Without a clear definition of what customers your bank wants, your marketing dollars and management talent won’t be optimized. Profitable customers and good customers can look different. Given a group of potential clients, you may select your list of winners by business and household accounts. Another banker may choose those who look like good loan customers. Wouldn’t it make sense if everyone at your bank was on the same page? That may not be a single definition, but above all, your bank needs a common understanding of what fits. I’m going to outline one bank’s attempt to come to internal harmony on this important matter.
Bank management ha s identif ied the types of attributes it wants, such as intent, product usage, balances, and behavior, and set a level of profitability. Customers and prospects are plotted on two axes—profitability versus number of customer profitability attributes (see chart). Thus, the most desired targets fall into the upper right quadrant, exhibiting the highest levels on both axes. The chart’s green trend line shows potential target customers. This is no mere exercise. Getting a clear understanding of what customer attributes you want will put you light years ahead of most banks, since too many are willing to take on all customers. Taking this effort enables an institution to go after “look alike” customers in a very focused fashion. By defining what good customers look like, bank employees will stand a better chance of knowing them when they see them. And your institution will be able to structure its brand to better attract those desired customers.
Chris Nichols, a member of the Banking Exchange Editorial Advisory Board, is chief strategy officer at $4.7 billionassets CenterState Bank Central Florida, N.A.
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